Athena Field News
07 Jun 2013
Further to the announcement on 23 May 2013 that the boards of Lochard and Parkmead had reached agreement on the terms of a recommended all-share offer by Parkmead for Lochard to be effected by means of a Court-sanctioned scheme of arrangement under Part 26 of the Companies Act 2006 and the announcement by the Company on 31 May 2013, Lochard shareholders should be aware of the following information in relation to the Athena field and Lochard's exploration licences, and their significance to the Company.
Any decision in relation to the offer should be made solely on the basis of the information that will be set out in the circular to Lochard shareholders containing the terms and conditions of the offer from Parkmead. It is expected that the Scheme Circular will be posted to Lochard shareholders and, for information purposes only, to Lochard share incentive scheme participants in mid-June 2013.
Athena
The Field Development Plan ('FDP') was approved by the Department of Energy & Climate Change ('DECC') in September 2010. Original recoverable mid case reserves were estimated at approx. 15 million barrels ('mmbbl') (gross), based on four production wells and one water injector, with upside potential of 31 mmbbl (gross) in total based on six production wells (i.e. if two additional production wells are drilled).
Sproule International undertook an independent reserves assessment for Lochard in 2012 and estimated original recoverable Proved Developed Producing reserves at 18 mmbbl (gross) and Proved plus Probable reserves at 26 mmbbl (gross). Approx. 3.6 mmbbl (gross) of oil has been produced as at 31 May 2013. It is the opinion of the Lochard Directors that extra investment in wells would be required to achieve the reserves consistent with the Sproule Proved plus Probable estimate.
The field was developed with four production wells and one water injector with the expectation that the economic viability of adding two extra production wells could be assessed once reservoir performance from the first four wells was understood. The FDP projected initial production to be 22,000 barrels of oil per day ('bopd') (gross) from the four wells producing at the well design rates; these rates depended on the performance of Electrical Submersible Pumps ('ESPs'). The well completions incorporated two such ESPs in each well with the intention that together, they would provide uninterrupted well performance for approx. five years. ESPs are typically expected to last for a period of two to three years. As the field utilises a Floating Production Storage and Offloading ('FPSO') vessel, workovers to replace these ESPs would require the intervention of a drilling rig and the timing of any workover would therefore depend on rig availability.
The Athena field began producing around the end of May 2012 at an unexpectedly low level varying between 10,000 and 12,000 bopd (gross). Only two wells were producing at expected levels and one well had only one pump available. Despite that poor start, production had stabilised until recently at between 10,000 and 11,000 bopd (gross). Fears of early water breakthrough have been unfounded removing the probability of very low reserves recovery, but it is still too soon to predict production levels both in the short term and medium term (that is, over the next two years).
Like all oil and gas fields, the production from Athena will decline over time and, in their report to Lochard, Sproule have forecast a production decline rate of approximately 20% per annum from 2013 onwards under the Proved Developed Producing reserves case. Additionally, Sproule have forecast that it would not be economically viable to continue to produce from the Athena field at an estimated daily production rate between 3,500 and 4,000 bopd (gross). At this point, the costs of production would exceed the revenue generated and the field would therefore be decommissioned.
Workover activity and the drilling of additional wells could slow or reverse this projected decline, lead to increased recovery and extend the economic life of the field. However, there are no current plans or capital budgeted for workover or drilling of additional wells and the Directors believe that such a decision will not be taken until a longer production history at Athena has been established.
Current Athena production issues
As noted above, although initial production was below expectations, Athena has produced relatively consistently to date but there remain uncertainties, a number of which have been highlighted over the past month:
Wells
On average, between 80% and 85% of production comes from two wells, P3 and P4. Any loss of either of these wells would lead to a significant loss of revenue. The field co-venturers are making contingency arrangements to be able to replace ESPs in either of these two strongly producing wells in the event of any failure. The timing and cost implications of such an operation are unknown at present, but would be material to Lochard. The Directors do not believe that such expenditure is likely to occur in the near future but a cash reserve needs to be built up for Lochard to be able to meet its share of any contingent costs. In this respect, it is noted that well P4 has now been switched to its second ESP, after the failure of the first ESP which occurred earlier than expected. As noted above, ESPs are typically expected to last for a period of two to three years, although two of the ESPs used in the first phase of the Athena field have failed within the first year.
There are currently no plans to undertake recompletion work in the event that the two underperforming wells, P1 and P2, fail. Well P2 (which had been producing at approximately 600 bopd) has recently failed and requires additional spend on remedial works, although it is not expected to require recompletion. Lochard's share of funding the remedial works is currently estimated at approximately £200,000, which the Company expects to fund from its payment for recent oil sales due to be received in mid-June.
Neither the switch to the second ESP for well P4 nor the failure of well P2 are, individually, considered material in the normal course of business for Lochard. However, these events highlight the risks of being a single asset company should equipment fail. Current production from Athena, from the three producing wells, is approximately 9,300 - 9,600 bopd.
Water production
A positive aspect of production until recently had been production of water at only trace levels (less than one per cent.) which is encouraging for indicating potential reserves recovery. Since the Lochard operating and trading update was released on 31 May 2013, it has become clear that the water percentage in Athena production has risen to an estimated two to three per cent. At these levels of water production there is no basis for making informed longer term production predictions, although monitoring the trend of water cut development over the next six months will improve the operator's ability to make such predictions. This new development does, however, highlight the uncertainties in making assumptions about Lochard's production income from Athena over the next two years.
Further background on Lochard's exploration licences
In 2012, Lochard had an interest in a conventional exploration licence (Thunderball) expiring on 13 February 2013 and six promote licences from the UK Continental Shelf (UKCS) 26th Licensing Round, which all had expiry dates of 9 January 2013. In the normal course of business, Lochard would have been required by 9 January 2013 either to relinquish the promote licences or to commit to spend material sums on exploration drilling.
In late 2012, it was clear to the Lochard Board that following the failure to complete a third party farm-out to meet the £16 million commitment in respect of the Thunderball licence, DECC would revoke Lochard's operator status and Lochard would no longer be allowed to operate any North Sea assets. The loss of Lochard's operator status also limited the opportunity to seek further retention flexibility with respect to any of the promote licences. The Thunderball licence lapsed on 13 February 2013.
The promote licenses were available for farm-out for a long time with Aimwell Energy, Lochard's technical partner and exploration consultant, leading the process on behalf of the Company. In January 2013, Lochard relinquished three of its promote licences (13/16b & 17, 14/27b and 16/8c) as they were deemed not worth pursuing following extensive technical work and an inability to find a suitable farm-in partner. Aimwell were successful in generating interest from a North Sea operator in the remaining three licences and DECC approval was obtained for Lochard to keep the licences extant until a farm-out transaction was completed.
DECC approved the farm-out to another North Sea Operator effective 2 April 2013 with a deadline of 2 July 2013 (three months) for the farm-out to be completed; the Operator was also approved as the operator of these licences.
It remained the intention of the Board to not commit funds for exploration drilling on these licences without having the required financial resources to do so. Based on feedback from potential partners as part of the Formal Sale Process as well as the specific farm-out process, it was apparent to the Board that there was little interest in these licences. Accordingly, the Board believed that future farm-downs of these licences would be challenging and its view evolved to the point that in April 2013 the Directors resolved not to enter into any agreements in respect of the three exploration licences that would require significant further funding, without first securing a merger partner that had a stronger balance sheet and financial capacity.
In the opinion of the Directors, the Company would not have sufficient funds as a stand-alone entity to meet the likely drilling costs and other commitments to which Lochard would be exposed from January 2014 on these three exploration licences, while also maintaining sufficient resources to meet potential contingencies in connection with the Athena field. Given Lochard's financial position, the Board do not believe it would be in the best interests of Lochard shareholders to expose the Company to unfunded exploration drilling commitments that are likely to materialise in 2014.
The Directors continue to believe, therefore, that the best way for Lochard shareholders to retain an interest in these three exploration licences would be to merge with a suitable partner, such as Parkmead. Parkmead has an experienced oil and gas team with a successful track record of exploiting exploration and production opportunities in the UKCS and is therefore well placed to maximise value from these licences. In the absence of such a transaction, these licences are likely to lapse and the Company's only remaining asset would be its 10 per cent. non-operated interest in the Athena field.
The Board recognises that the Parkmead offer is unlikely to complete before DECC's deadline of 2 July 2013, although it is possible that the Company in conjunction with Parkmead may be able to agree an extension to this deadline given Parkmead's relationships. The Lochard Board does not believe that any agreement with DECC can be reached until there is greater certainty on Parkmead's offer for Lochard.
Implications for the Parkmead offer
The Directors do not see the recent operational issues as a serious impediment to the longer term performance of Athena, although there may be a requirement for remedial investment and the recent pump failures have led to a reduction in current production. The recent events described above highlight the need for Lochard to build up a significant cash reserve over the medium term to cover the contingencies of operational down time and the cost of remediation.
In summary, the Board remains positive about the long term potential for Athena and believes that drilling further wells in the future may be justified to increase reserves; any drilling will be subject to partner approval. There are currently no plans for such investment in the next two years. However, a critical issue to be noted is that sustained cash flow from Athena is dependent on two wells continuing to perform without interruption and one of these is now operating on its second pump. Loss of production is also possible from the two lower production wells which will not be recompleted in the event of failure.
In making their decision regarding the Parkmead offer, Lochard shareholders should take into consideration the fact that contingent investment that may be significant for Lochard could be required in the next one to two years and that the Board's first priority is to be able to meet its share of costs.